Earlier today, the U.S. Federal Reserve (Fed) announced that it would maintain the Federal funds rate target at 0.25%-0.50% and the Bank of Japan (BoJ) would keep its benchmark interest rate unchanged at -0.10%.
Case for Rate Hike is Stronger but Cautious Fed is Waiting for More Evidence
Leading up to the announcement, the Fed was widely expected to leave the target rate unchanged. However, it was surprising to see dissent from three Regional Presidents, who would have preferred to raise the target to 0.50%-0.75%.
Stable 2.00% inflation and maximum employment remain the two objectives of the Fed. They expect inflation to remain low in the near-term due to depressed energy prices but expect to reach 2.00% in the medium term. Regarding labour markets, the Fed noticed that while the unemployment rate had remained unchanged from the previous meeting, solid job gains have prompted strong household spending. The weak point in the economy continues to be business spending.
The expectation for 2016 real GDP growth is down to 1.80%, from 2.00% from the July meeting. Expectations for unemployment and core inflation changed little as the Fed expects full employment and inflation to be slightly below their target at 1.80% in 2017.
The likelihood of a December hike has increased, but it is expected that any future increases will be gradual and the rate will remain below levels that are expected to prevail in the long run. The Fed expects one more rate increase this year and one to two hikes in 2017.
BoJ Leaves Rates, Focuses on Flexibility and Targets Stable Inflation
Predictions on the BoJ’s direction were less clear as the central bank reviewed developments in economic activity resulting from its ongoing easing and negative interest rate policies. The BoJ has decided to focus on controlling short and long-term interest rates and expanding the monetary base in hopes of stabilizing inflation around the target of 2.00% as quickly as possible.
As a result, the BoJ has created policy flexibility. If necessary, additional easing could be achieved by cutting the short-term benchmark rate and the long-term target rate. It could also expand asset purchases as has been the case since the introduction of the BoJ’s easing program. Furthermore, the BoJ could pursue accelerating the growth of the monetary base.
How do the Fed and BoJ decisions impact MD portfolios?
Global markets have responded positively to both announcements in the short-term. The announcements may influence certain companies (such as banks), currencies, as well as the general levels for yield and the relative attractiveness of different types of bonds. There may also be some incremental changes in the price of some securities but not in their underlying values–something that MD’s active managers will try to capitalize on.
We do not expect the announcements to have material impact on the overall positioning or performance of our funds and pools. In general, the impact of today’s announcement is minimal for MD portfolios but we will continue to monitor the situation closely. We encourage you to contact your MD Advisor if you have any questions.
For more information about the U.S. Federal Reserve interest rate changes, please read U.S. Federal Reserve Still Likely to Raise Rates in 2016.